Monthly Archives: July 2013

What to do when fraud is discovered
Jul 10

What To Do When You Discover Fraud

By Charles Hall | Fraud

You need to know what to do when fraud is discovered. Today, I discuss steps to take when theft is detected.

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Courtesy of iStockphoto.com

What To Do When Fraud is Discovered

When fraud is suspected at your governmental entity, two gnawing questions arise:

  1. Is fraud really occurring?
  2. If yes, how much money was taken?

And possibly a third  – Am I going to be fired? (It’s normal to feel some fear. The thermometer goes up when fraud is suspected.)

It’s at this point that two more questions arise:

  1. Who should I hire to answer the two questions above?
  2. How much will it cost for this service?

You can pick up the phone and call those who are in the know about fraud audits – possibly another government or an audit firm – or you can issue a request for proposal (RFP). Many governments do the later (though I’m not sure it’s the best option). If you can find a reputable, fair audit company, hire them. (Ask for at least two references.) If not, then here’s some information about issuing fraud-related RFPs.

RFPs for Fraud Services

First let me say that governments may need outside assistance in preparing an RFP for fraud-related services. It’s not every day that fraud is encountered; consequently, when fraud occurs, governments often struggle with writing the RFP. Copying your financial statement audit RFP will probably not work; fraud audits and financial statement audits are two completely different types of services. Additionally you may not desire to seek out the lowest bid (yes, you read that correctly). There’s one thing worse than fraud: it’s handling the effects of fraud incorrectly. Let me suggest a method that I believe will minimize costs while providing you with quality audit services.

Governments may want to break down the engagement into two phases:

  1. Predication
  2. Audit

What is predication? It is the early part of the investigation where the auditor determines whether there is enough evidence to merit the second phase of the investigation: audit. The auditor is simply sniffing around in the suspected areas to see if more work should be performed.

Once the auditor has performed the predication phase, the government can decide, based on the evidence uncovered thus far and the estimated price of the audit phase, whether it desires to proceed. This method allows the government to minimize costs; rather than asking for a full-blown investigation up front, you take steps. I have seen some investigations end with the predication phase – there simply was not enough evidence to proceed.

The government should ask for a maximum price (or range of pricing) for the predication phase. Also the government may desire to request a schedule of hourly rates; those same rates may be used in the second phase of the investigation.

The government should normally use the same firm to perform the two phases of the investigation. So basically the firm that wins the predication bid will be the auditor for the full project. If the government elects to proceed with the audit phase of the project, the government should request that the audit firm invoice by hours worked, staff level, and hourly rates. (This creates some transparency in the billing process.)

Summary of Work Flow and Billing

In summary, I am recommending that you:

  1. Bid the predication phase and allow the audit firm to provide you with a maximum price or range estimate (e.g., $8,000 to $10,000).
  2. Select the audit firm.
  3. Allow the firm to perform the predication phase and provide a report.
  4. Make a decision about whether to continue the investigation.
  5. Allow the audit firm to perform the audit phase (if needed).
  6. Receive a final audit report.

I recommend that the audit phase be billed at hourly rates. Why? Because fraud engagements tend to be amorphous. The auditor may dig and find additional issues that could not be discovered in the predication phase. Think of this like an archeologist excavating a house; rather than just a house, he may find a village – though we hope not. As a trade-off to receiving a full bid price, the audit firm can provide detailed invoices that reflect the hours worked, staff level, and hourly rates.

GASB 61
Jul 07

GASB 61 – Financial Reporting Entity

By Charles Hall | Accounting and Auditing , Local Governments

I well remember how confused I was when GASB 14 came out – even though Harold Monk did his best to enlighten me. Since then, I don’t know how many entities I’ve looked at, trying to determine whether they were component units. I do know I have become well acquainted with the flowchart in GASB 14; strangely enough, we have become friends (yes, I know it’s weird having a flowchart for a friend, but such is my life). We now have an updated flowchart in GASB 61 – a new friend I guess.

GASB 61

GASB reconsidered GASB 14 and created GASB 61, Financial Reporting Entity: Omnibus – an Amendment to GASB Statements No. 14 and No. 34. The effective date is for periods beginning after June 15, 2012. 

Let’s take a look at GASB 61. First, we will consider whether an entity should be included as a component unit, and then we will look at whether the entity should be blended or discretely presented.

1. Evaluating Inclusion of Potential Component Units

First ask, “does the primary government appoint a voting majority of the potential component unit’s board?”

If yes, you will include the component unit if the primary government:

  1. has the ability to impose its will upon the potential component unit or
  2. has a potential financial benefit or burden related to the potential component unit (PCU)

If no, consider whether the potential component unit meets the fiscal dependency and financial benefit/burden criteria. If yes, then include the component unit. If no, ask whether it would be misleading to exclude the potential component unit; if it would be misleading, then you will include the PCU (normally discretely presented).

2. Blended or Discretely Presented Decision

Blend the component unit if any of the following three criteria is true:

1. If the component unit’s governing body is substantively the same (basically having the same board members) as the governing body of the primary government, then you will blend the component unit into the primary government provided:

    • there is a financial benefit or burden relationship, or
    • the primary government has operational responsibility for the component unit.

Operational responsibility is defined as managing “the activities in the essentially the same manner in which it manages its own programs, departments, or agencies.”

(Notice the primary government’s legal control of the component unit does not affect the blending decision.)

2. Another consideration – commonly known as the exclusive benefit criterion –  is whether the component unit’s goods or services are entirely or almost entirely provided to the government itself (this does not include providing services to the government’s citizenry or customers). If the answer is yes, then the component unit will be blended.

university foundation, for example, is usually designed to (and often does) exclusively benefit the university (the primary government) and would, therefore, be blended.

A university hospital, by contrast, will be presented discretely (in the university’s financial statements) since the hospital is primarily providing benefits to patients rather than the government. (This is true even if the articles of incorporation for the hospital state that the entity is designed for the exclusive benefit of the university.)

3. GASB 61 includes one new blending criteria: if the primary government will repay entirely or almost entirely (with resources of the primary government) a component unit’s total debt outstanding (including leases), the component unit will be blended. The standard does allow for discrete presentation if the primary government’s resources are the second source of debt repayment or if resources received from the primary government are among other sources of repayment available.

If the component unit does not meet any of the three blending criteria, then it will be presented discretely.

Jul 02

Consolidating Not-for-Profit Entities

By Charles Hall | Accounting and Auditing

How would you respond to the question, “how do I know when a not-for-profit entity should consolidate a related not-for-profit entity?”

Here’s a brief overview.

Key Consolidation Issue

The main key in determining whether a not-for-profit should consolidate another entity is control.

FASB defines control as the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.

Consolidation Decision

The FASB Codification addresses not-for-profit (NFP) consolidations as follows:

  • Consolidation is required for 1. through 3. below.
  • Consolidation is permitted but not required for 4. below.
  • Consolidation is not permitted for 5. below.

Controlling Financial Interest

1. 958-810-25-2 – The reporting entity is the sole corporate member of the related NFP
2. 958-810-25-2 – The reporting entity has a controlling financial interest through direct or indirect ownership of a majority voting interest in the other NFP

Control Combined with an Economic Interest

3. 958-810-25-3 – The reporting entity controls another NFP through a majority voting interest in its board and has an economic interest in that other entity (e.g., reporting entity appoints 3 of the 5 voting members of the related NFP)
4. 958-810-25-4 – The reporting entity controls an NFP through a form other than majority ownership, sole corporate membership, or majority voting interest in the board of the other entity and has an economic interest in that other entity (control may be established by contract or an affiliation agreement)

Other

5. 958-810-25-5 – If the reporting entity does not have both control of and an economic interest in the related NFP, then consolidation is not permitted.

Note – There are additional rules for consolidating for-profit entities into NFP financial statements.

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